Question

Brief Exercise 15-17 Lessor; effect on earnings; Type B lease

At January 1, 2016, Café Med leased restaurant equipment from Crescent Corporation under a Eight-year lease agreement. The lease agreement specifies annual payments of $35,000 beginning January 1, 2016, the beginning of the lease, and at each December 31 thereafter through 2023. The equipment was acquired recently by Crescent at a cost of $185,000 (its fair value) and was expected to have a useful life of 12 years with no residual value. The company seeks a 8% return on its lease investments. Assume that the risks and rewards of ownership are deemed not to have been transferred to the lessee.

Respond to the question with the presumption that the guidance provided by the proposed Accounting Standards Update is being applied.

What will be the effect of the lease on Crescent’s (lessor’s) earnings for the first year (ignore taxes)?

Answer 1

	annual lease payments	35000
	Period	Jan16 to dec2023	8 years
	Fair value of the asset	185000
	useful life	12 years
	int rate implicit in the lease	8%
	What is the effect of lease on lessor's earnings for the first year?
	As per IFRS 16, which will be effective for lease accounting from Jan1, 2019,
	in the books of lessor, the accounting treatment depends on the transfer of significant
	risks and rewards. (unlike lessee, the treatment remains unchanged from IAS 17).
	In this case, significant risks and rewards are not transferred to the lessee. Hence, the lessor
	should treat this as Operating lease and should be accounted as an asset. Lease income is recognised
	over the lease term, on straight line basis.
	In the books of lessor:
	Year 1:	Debit	Credit
1	Cash	35000
	Lease income		35000
	(recognition of lease income in year 1)
2	Depreciation	15416
	Leased asset		15416
	(being accounting of depreciation for year1)
	Cost of the asset	185000
	useful life	12 years
	depreciation	15416.66667
	Thus, in first year, the income is increased by $35000 and reduced by $15416, due to charging
	of depreciation. Thus there is net increase of $19584 (35000-15416) in profit and loss statement.